The warning that went unheeded

TEXT OF STORY

Kai Ryssdal: Despite its name, the Commodity Futures Trading Commission does more than keep an eye on trades in pork belly futures and winter wheat prices. The CFTC is the federal agency that regulates trading in derivatives. Things like credit default swaps that you'll recognize from the days of the AIG bailout. Those swaps helped drag the whole financial system to the brink of collapse last year.

There's a lot of talk lately about coming up with new regulations for the derivatives market and the CFTC is in the financial news all the time. In the mid and late 1990s, though, most people didn't even know the CFTC existed. They probably didn't know about the warnings its chairman was giving about the dangers of derivatives trading. And they almost certainly didn't know she was ignored.

Tonight Frontline on PBS offers its documentary about that story "The Warning." Frontline's Michael Kirk reports.

MICHAEL KIRK: In 1996, the U.S. economy was on a roll. The stock market was mid-way through its greatest run in history. And in August, President Bill Clinton named a new head of the CFTC -- Brooksley Born.

Her first priority: to look into the booming new market in over-the-counter derivatives.

BROOKSLEY BORN: My staff began to say how big this was and how little information they had about it.

That year, the market in over the counter derivatives was worth roughly $20 trillion and growing at about 20 percent annually. But it wasn't the market's size or the speed of its growth that worried Born.

BORN: There was no transparency. There was no record keeping requirement imposed on participants in the market. We had no information.

Born believed the lack of transparency left the market open to fraud.

Joe Nocera's a reporter with the New York Times. He says fraud came up during Born's first meeting with the Chairman of the Federal Reserve, Alan Greenspan.

JOE NOCERA: He said something to the effect that, "Well, Brooksley, we are never going to agree on fraud. You probably think there should be rules against it." And she said, "Well, yes, I do." He said, "You know, I think the market will figure it out and take care of the fraudsters."

Instead of taking the hint, Born began investigating. She immediately ran up against opposition from the president's Working Group on financial markets. She even got an angry call from Larry Summers, the Deputy Treasury Secretary.

BORN: They were totally opposed to it. That puzzled me. You know, what was it that was in this market that had to be hidden? So, it made me very suspicious and troubled.

Summers, his boss at the Treasury Robert Rubin, and Alan Greenspan were big believers in letting the markets look after themselves.

Mark Brickell is a former derivatives banker at JPMorgan Chase, and an industry lobbyist. He says Greenspan wanted to regulate over-the-counter derivatives as little as possible.

MARK BRICKELL: He had said that he perceived derivatives to be one of the greatest innovations in recent financial history, that the contracts because they helped businesses and banks and governments manage the risks to which they were already exposed more efficiently than they could have done before, were doing something that was useful for the financial system.

Where Greenspan saw benefits, Born saw risks. She prepared a document that laid out her concerns. The president's working group discussed it at an emergency meeting in May 1998.

MICHAEL GREENBERGER: I happened to be sitting behind Brooksley and behind Greenspan.

Michael Greenberger was one of Born's aides at the time.

GREENBERGER: Greenspan turns to her, she turns to him, his face is red, and he's clearly quite upset. He was very adamant that this was a serious, serious mistake, that it would cause untold damages to the financial services market and that she should stop and not do this.

Undeterred, Brooksley Born published her list of concerns. The members of the Working Group struck back. They insisted Congress shut Born down.

Four congressional committees called on her to testify. But they weren't persuaded. Instead, they stripped the CFTC of its powers to regulate the markets. Born quit. Ten years later, she watched, appalled, as the market collapsed.

BORN: It was my worst nightmare coming true. The toxic assets of many of our biggest banks are over-the-counter derivatives and caused the economic downturn that made us lose our savings, lose our jobs, lose our homes. It was very frightening.

Despite the financial crisis, the market in over-the-counter derivatives is now more than $450 trillion in size. The House Financial Services Committee approved new rules for the market last week. But many people say the rules aren't enough to protect the economy.

In Boston, I'm Michael Kirk for Marketplace.

RYSSDAL: "The Warning," which tells the story of Brooksley Born's clash with Alan Greenspan airs tonight on PBS stations.